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ErngsSeason

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Four times a year, we go through a little ritual called "earnings season".

It is during these seasons that companies report their quarterly earnings. And it is during these seasons that companies which disappoint in any way whatsoever are taken out and shot. Unless the carnage is isolated, an entire group or sector can suffer. If it's extensive, a complete market correction might ensue.

Quarterly earnings weren't always all that important.

In the days before the grand bull market began and the school crossing guard began to daytrade, club members were of a different ilk. As Michael Brush reports in Lessons from the Front Line, the markets were more or less dominated by professional investors who had a long-term view about stocks. They weren't anything like a lot of money managers today. Typically, the old timers would buy and hold for at least one to three years. To them, annual results were the real read on how a company was doing. Quarterly numbers were just minor progress reports along the way. Now things are different. Many more people are responsible for managing their own retirement money. They are constantly shopping around for the fund manager with the best performance. Or their advisors are doing it for them. The report card they turn to - rightly or wrongly - is the manager's performance in the most recent quarter. This puts a lot of pressure on the fund managers to produce decent gains every three months. After all, a big part of their pay is a percentage of the assets under their management. Not only can fund managers no longer shrug off a subpar quarter, they are forced to obsess on it, willingly or not, becoming the short-term traders they are forever urging their subscribers to shun. And because of the Internet, they can't hide behind lag time in order to analyze the numbers and explain what they mean in any sort of responsible context, much less dress things up and make them look better than they are. Instead, they receive the numbers at about the same time as everyone else, and before they can put pencil to paper, the stock has been plugged fulla lead.

industry of its own, and companies which beat those estimates were amply rewarded for their efforts. Those which failed to meet estimates at all were gunned down in the streets. Those which only met estimates without actually beating them received flesh wounds at best. At worst they might lose an arm or a leg. These activities did not go unnoticed by the smarter companies, notably Microsoft, which began to show a conservatism about their upcoming quarters in continuing performances that would have done John Barrymore proud. By lowballing, they were able to beat the estimates every time and escape the wrath of the waiting mob.

Predictably, earnings estimation and the reporting of earnings estimates became an

As time went by, however, the lowballing strategy became pretty transparent, and only

the slowest companies failed to catch on. This gave rise to the "beat estimates by a penny phenomenon", which was and is the result of a level of creative accounting unmatched in history, except perhaps by movie studios, and the Mob. However, when great waves of companies began "beating estimates by a penny", professional investors -- no flies on them -- came up with the notion of the "whisper number", which is essentially the number that everybody really would have expected the company to come up with if its guidance and its books were written in something a bit more permanent than sand.

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ErngsSeason

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Meanwhile, back at the ranch, CEOs and other managerial types were being compensated

based not so much on how the company did but on how well the stock did. This provided added hazards to earnings seasons, particularly if the company was in real trouble, even if for only that quarter, and knew damn good and well that it wasn't going to beat estimates, even by a penny, much less make the whisper number. Thus the advent of "preannouncements" and what came to be known as "the confession season", a period before earnings season officially began in which fearful and penitent company officers threw themselves upon the mercy of the investment community. Yeah. Right.

There are all sorts of interesting and new phenomena which spring up as a result of these

little rituals and thus surround them. For example, given the length of earnings seasons themselves, adding the confession periods to them means that there are only a few weeks during the year when investors aren't focused on earnings. In other words, as soon as one season is over, the confession period for the upcoming season is only a few weeks away. Another quizzical little phenomenon is the tendency of many investors to "bid up" the price of a stock prior to earnings, then sell it immediately thereafter, giving rise to the axiom of "buy on the rumor and sell on the news". And it doesn't take much insight or foresight to see that the logical extension of this practice is to bid up the prices of some stocks many years into the future, giving rise to PEs (or PSRs, if there are no earnings, which is likely) which extend into the hundreds, or even thousands.

But for our purposes here, the object of the investor's attention is the stock that has been

unfairly shotgunned to a pulp. And take careful note of the word "unfairly". Opportunities of this sort will come up at least four times a year, though not in the same stocks each time. The trader/investor who knows the company and knows the fundamentals of the company can do quite well for himself if the company is in fact on sale and is not rather verging on bankruptcy. This applies not only to the company that preannounced the difficulty, but also to its brothers and sisters who may have innocently become caught in the cross-fire.

Remember first and foremost that confession and earnings seasons are a showcase for

herd mentality at its best, and that fund managers are just as susceptible to this mentality as the retail trader/investor. After all, it's only your money, but it's their Lexus, and their corner office, and their summer home in the Hamptons, and their charge account at Barney's. Keep in mind also that they all went to the same schools and took the same courses from the same professors, drink at the same bars, eat at the same restaurants, belong to the same clubs. If you can resist the siren-call of the mob and think for yourself, reaching your own decisions, these events can present irresistible opportunities.

First, as mentioned in Bottom Fishing, have your list ready and make sure it's up-to-date. Review it weekly, if necessary, but have it ready. Also make sure that you've worked out this whole trader/investor thing ahead of time. If you buy the company that preannounced, you may be nursing it for a while. Second, if it just so happens that the company which preannounced is in fact in trouble
and its stock is likely to be dead money for a while, look for "cousin" stocks, i.e., stocks which are pulled down for no other reason than they are in the same group or sector, in the line of fire. Keep in mind, though, that what affects one may affect others, and the fact that the stock you have your eye on hasn't preannounced doesn't necessarily mean that it's clean. These first and second strategies are risky. Less risky is buying a stock which plummets due to a general market decline, or at least due to problems in an entirely different group or sector.

Third, listen to the bellwethers.

If they're preannouncing problems, don't expect your little guy to shine. He just might, but it's best to be extra cautious. If the generals fall, the soldiers are likely to do so as well, fairly or unfairly.

Fourth, if you're buying the wounded as a trade, make sure you've got the focus and the

discipline to cut and run at the least sign of further trouble. Otherwise, your trade may wind up becoming an involuntary investment. The volatility during these periods can be extraordinary, and unless you're outfitted with the proper equipment and you have the skill and the experience to compete with professional traders, adopt a little humility and stalk your prey for the best possible and lowest-risk moment.

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ErngsSeason

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the third quarter turns on September 30, nailing up the sign for fourth-quarter confessions season. October is the first month of the last quarter. Those analysts who issued such glowing reports the previous January are running out of time, and if the companies they pumped up look wobbly, those analysts are going to be concerned more with saving face (and their bonuses, if not their jobs) than on standing by what were their convictions (estimate? what estimate?). Additionally, the companies themselves are running out of time. They've got only a few months left to meet those expectations which investors have been carrying for nine months. Little wonder, then, that October can be so treacherous. On the other hand, the money that comes rushing in during November and December does so largely because there is a perception that the worst is over. The New Year represents a new beginning, a clean slate, a whole year to estimate, forecast, and predict. Given the emergence from the darkness of October, those estimates are likely to be pretty sunny, driving prices substantially higher from January forward through the spring. Many professionals believe, in fact, that the bulk of one's annual profits are made between November and May. It's worth thinking about.

Fifth, understand that one of the reasons why October has such a bad reputation is that

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